In response to value investors and Coca-Cola shareholder David Winters (Trades, Portfolio) questions about the company's proposed compensation plan, Coca-Cola released the following:

Do kids today still open lemonade stands? I hope so because it is a great way to learn about making good business decisions. That mindset – acting like an owner – is one that successful businesses of all sizes encourage. One way we do this at Coca-Cola is through an equity compensation plan. This essentially offers managers incentives of stock ownership – a real stake in the business – if certain business goals are met.

As a public company with shareowners big and small, we believe it is important to explain our business in simple terms and respond to those who have a different opinion about how to run the business. After all, they are owners too.

Here is how the equity plan works. A portion of the compensation for a large group of managers is provided in the form of stock options and “performance units” that are linked to the company’s performance. The value of that compensation depends on the increase in the value of the company. If the actions taken by the people running our business result in growth, then the stock price goes up and they benefit. Similarly, if the business doesn’t perform as well, it is likely that the stock price will reflect that and those managers will receive less compensation. We call that “pay for performance.” The goal is to promote the success ofThe Coca-Cola Company by linking the personal interests of employees to those of shareowners. If the company doesn’t perform, managers don’t benefit.

So why has this investor raised questions about the equity plan? According to his letter, he believes that this plan would overly “dilute” the value of the shares he, or other investors, own. But this is not at all the case. Let me explain.

The equity plan requires that we issue shares in the company. If we only did that, then the value of a share of the company would be “diluted” because the individual share would represent a smaller ownership fraction of the company. But that is not the only action we take. We protect the value of our shareowners in a number of ways:

First, we regularly repurchase shares in the stock market. This reduces the amount of shares on the market which offsets the potential dilutive impact. In 2013, we repurchased $4.8 billion of our stock. That far exceeded the $1.3 billion repurchased related to employee stock options exercises.

Second, the plan dictates that employees leaving the company forfeit equity compensation that has not vested.

And finally, because this compensation is tied to company performance, there is the possibility that it will not be earned.

Mr. Winters overstates the dilutive impact of our equity plan. Actual dilution related to equity plans over the last three years has been less than 1% per year and is expected to be in this range going forward.

He also raises another point that is plain wrong – that we are “gifting” tens of billions of dollars to management. He arrives at that figure by calculating the total value of the shares allotted to the plan at the current stock price. This misses two very important facts. First of all, the value of a stock option is based on the difference between the grant price and the stock price, not the total value of the stock. For example, if an employee is given a stock option at $30 and the stock price goes up to $40, the employee can get $10 – not $40. And, most importantly, this compensation has to be earned. This plan only provides compensation if our business performs at a high level.

We believe that our proposed equity plan is financially sound and encourages our employees to act like owners by tying their interests to those of everyone who owns a share of The Coca‑Cola Company. Our business may be a bit more complex than a corner lemonade stand, but at the end of the day, we want our employees to think and act like owners.

About the author:

Comments

>> The goal is to promote the success ofThe Coca-Cola Company by linking the personal interests of employees to those of shareowners. If the company doesn’t perform, managers don’t benefit.

I like to ponder this sort of stuff from the perspective of an outright owner.

If I were the outright owner of a business and the manager of that business came to me and explained to me that he would only perform well if I gave him part of the business in order to "link his personal interests with mine". He'd be out there looking for a job before he'd finished his sentence.

While I do think it's important to reward performance, I also think:

1) Coca-cola is a busisness an idiot could run. The very best manager is not going to double the company between now and 2020 and the worst of managers will have trouble slowing down growth to less than 5% per annum.

2) There are alternative ways of rewarding managers for performance.

3) The argument that there will be no diltion because the company will buy back stock to offset the stock awarded to managers, is more than dumb.

If the board thinks management should be paid more, let them say so, but this rebuttal by the BoD is an insult to the intelligence of everyone, including shareholders.

>> The argument that there will be no diltion because the company will buy back stock to offset the stock awarded to managers, is more than dumb.

Come to think of it, from an owners perspective, they're saying it isn't so bad that they're taking a chunk of the business from you. You see, they are going to offset this by using cash, generated by the business, to buy another chunk of the business from you and cancel those shares.

So net-net, the bits you are left with aren't worth less.

Either they're dumb and should be dismissed or they're not dumb and should be prosecuted. Since I don't like attributing to malice what can also be explained by stupidity, I'll come down on the former.

Disclaimers: GuruFocus.com is not operated by a broker, a dealer, or a registered investment adviser. Under no circumstances does any information posted on GuruFocus.com represent a recommendation to buy or sell a security. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The gurus may buy and sell securities before and after any particular article and report and information herein is published, with respect to the securities discussed in any article and report posted herein. In no event shall GuruFocus.com be liable to any member, guest or third party for any damages of any kind arising out of the use of any content or other material published or available on GuruFocus.com, or relating to the use of, or inability to use, GuruFocus.com or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. The gurus listed in this website are not affiliated with GuruFocus.com, LLC.
Stock quotes provided by InterActive Data. Fundamental company data provided by Morningstar, updated daily.